FDIC Quarterly Banking Profile

The Federal Deposit Insurance Corporation (FDIC) just released its quarterly banking profile for the 12/31/2007 ending period. The content wasn't all that unexpected, but it is worth it to review the highlights:

1) Fourth-quarter net income of $5.8 billion was the lowest amount reported by the industry since the fourth quarter of 1991.

2) The average return on assets (ROA) in the quarter was 0.18 percent. This is the lowest quarterly ROA since the fourth quarter of 1990.

3) Trading losses totaled $10.6 billion, marking the first time that the industry has posted a quarterly net trading loss.

4) Net charge-offs registered a sharp increase in the fourth quarter, rising to $16.2 billion, compared to $8.5 billion in the fourth quarter of 2006. The annualized net charge-off rate in the fourth quarter was 0.83 percent, the highest since the fourth quarter of 2002.

5) Total noncurrent loans — loans 90 days or more past due or in nonaccrual status — rose by $26.9 billion (32.5 percent) in the last three months of 2007. This is the largest percentage increase in a single quarter in the 24 years for which noncurrent loan data are available.

Some surprises as well:

1) The magnitude of the decline in industry earnings was attributable to a relatively small number of large institutions. In contrast to the steep 102 basis-point drop in the industry’s ROA, the median ROA fell by only 14 basis points as seven large institutions accounted for more than half of the total year-over-year increase in loss provisions. It looks like the "smart money" screwed up more this cycle.

2) Capital Ratios still look fairly good:

The leverage ratio fell from 8.14 percent to 7.98 percent.

Total risk-based capital ratio, which includes loss reserves, increased from 12.74 percent to 12.79 percent.

Becky Quick Death Look

Check out this video excerpt from CNBC where Charlie Gasparino is talking about the Bond insurers.

Quick vs. Gasparino

At around 2:30 of the clip - Becky Quick gives Charlie a look like she wants to gouge out his eyes. There doesn't seem to be any love lost between these two.

Citigroup Death Watch

Citigroup filed its 10-K on Friday, and it contained its most recent updated capital ratios. We have written about these ratios previously in this post:

November 5, 2007

Here are the numbers for Citigroup as of 12/31/2007 according to its 10-K. The numbers are in billions, so add six zeros:

Total Tier 1 Capital - $89,226
Total Tier 2 Capital - $44,895
Total Capital (Tier 1 and Tier 2)- $134,121

Ratios

Tier 1 Capital - 7.12%
Total Capital (Tier 1 and Tier 2) - 10.70%
Leverage - 4.03%

Tier 1 risk-based capital ratio of 7.12% is calculated by dividing $89,226 by total Risk-Adjusted Assets of $ 1,253,321.

Total risk-based capital ratio of 10.70% is calculated by dividing $ 134,121 by total Risk-Adjusted Assets of $ 1,253,321.

Core capital (leverage) ratio of 4.03% is calculated by dividing $89,226 by adjusted average assets.

Some things to note -

1) The published 10-K ratios do not include some of the capital raising measures that Citigroup took in late December and January - proforma for that the Tier 1 Capital ratio would be 8.8%, well above regulatory levels.

2) On the flip side to that, there are future write offs coming at the end of the March quarter as well. These writeoffs will impact capital levels.

3) Its total tier one capital declined by only $1.6 billion over one year - fairly surprising considering the losses and write offs they took.

4) An interesting footnote that bears more study - "The impact of including Citigroup’s own credit rating in valuing derivatives and debt carried at fair value upon the adoption of SFAS 157 is excluded from Tier 1 Capital at December 31, 2007."

Does this mean that Citigroup is using monoline insurance ratings of AAA to value some of its capital. If that insurance was excluded then they would have to mark them down?

Chicago Fed Index

The Chicago Fed National Activity Index was released this morning and showed that the index was –0.58 in January, up from –0.69 in December. All four broad categories of indicators made negative contributions to the index in January.

One surprise in the release was that the index showed that January’s three-month moving average indicates low inflationary pressure from economic activity over the coming year.

The full release is here.

Ackman and MBIA Inc.

William Ackman, of Pershing Square Capital Management, has brought the act of monoline insurance bashing to new heights, elevating it to that of an Olympic sport. He has been all over the news the last few months, talking his book up, or down in this case. So I decided to go through his bear case thesis line by line to see if he in fact knows what he is talking about, or is he just trying to scare fellow investors out of the stocks he is shorting.

His case is made up of several arguments. I will attempt to analyze each one of them down to its simplest form, since insurance is well known for the density of its financials. I am using the data from the 149-page massif that he posted on his web site, dated November 20, 2007, and I am focusing on MBIA Insurance. I was inspired to look into this matter after I heard Marty Whitman of the Third Avenue Value Fund dismiss Ackman with the simple phrase “he doesn’t understand insurance.” There’s no better sport to watch than a battle of the “smart money.”

Ackman has made many claims:

1) The holding company will be insolvent by the second quarter of 2008.

2) Channel Re, a captive reinsurer that is 17% owned by MBIA, and that reinsures $43 billion in exposure is not an adequate backstop and these exposures will be brought back into MBIA.

3) MBIA has a "GIC business" which invests money held by municipals received from bond issuance. They invest that money for municipalities and pay a fixed fee to the municipalities. MBIA is restricted to AA or better investments but the spread earned implies they are taking too much risk.

4) MBIA is understating its losses by using a mark to model rather than a mark to market system.

5) MBIA's investment portfolio has more risk than it seems because the company owns triple AAA bonds that are insured by itself.

6) MBIA raises money to fund itself through an SIV called Global Funding and the company is having difficulty finding buyers for the medium term note paper that this entity issues.

Claim #1

Ackman states that the holding company will be insolvent by the second quarter of 2008.

A little background first. MBIA Inc. is a holding company that is a publicly traded entity under the symbol MBI. The holding company owns an insurance subsidiary called MBIA Insurance Corporation. The holding company has no actual operating businesses. It receives income in the form of dividends from the insurance subsidiary, and another business that is involved in investment management. The dividends paid are subject to approval by the New York State Insurance Department, which is responsible for regulating the insurance entity.

Ackman uses a cash balance as of 9/30/07 (slide 125) of $464 million and states that MBIA will be insolvent in somewhere between 2.2 and 4.9 quarters. This has already been proven incorrect as the company ended the year with a balance of $434 million at the holding company level (MBIA conf call 1/31/2008). His predicted cash burn of $95.4 million turned out to be only $30 million. Now in his defense, he did put a disclaimer in there that if MBIA raised more capital then the insolvency would be postponed. However, this capital was downstreamed to the insurance subsidiary so it is not clear how this capital would help the holding company except to the extent that it makes the insurance subsidiary stronger.

Ackman also states that MBIA won’t be able to access its credit line if it takes a writedown in excess of $2.4 billion (slide 126) since it will be in violation of its covenants. This was also proven incorrect as the credit line is intact and available as of the end of January (MBIA conference call 1/31/08). Of course the capital infusion helped here as well.

Furthermore, the cash flows that the holding company could expect in 2008 include the statutorily permitted insurance company dividend and the net income of the asset management business if MBIA decided to stop growing the asset liability management business. That total would be $639 million. (MBIA conference call 1/31/2008)

Perhaps this is why Ackman is so desperately lobbying the New York State Insurance Department to restrict payment of the dividend to the holding company. Also, keep in mind that the holding company pays a discretionary dividend to shareholders and did pay $43 million out to shareholders in January 2008. It could also cut this back if needed to save money.

According to MBIA at its conference call on 1/31/2008, the holding company has $1.2 billion in debt. Two issues are due in the next three years - $143 million in 2010 and $100 million in 2011. Interest expenses on the debt are $80 million a year, and other miscellaneous expenses of the holding company bring the yearly expenses to $250 million.

It does not seem that a liquidity crisis is at hand for the holding company.

Thrift Industry Update

The headlines making the rounds off of this report is the $5.2 billion collective loss that the thrift industry took in the fourth quarter of 2007. However, there is a lot of data in this report and I would urge everyone to read the entire thing. Here are some things I would like to point out:

1) The Office of Thrift Supervision (OTS) made money last year!! A miracle for a government agency and it probably did not include the government overhead, but refreshing to know that the OTS made $24 million last year. (Page 4)

2) The year end equity capital ratio was at 9.46%, the second highest ever. (Page 6) Compare that to the 3.17% in the middle of the Savings and Loan crisis in the 1980's.

3) Return on Average Assets was still positive for the full year at 0.19%, despite the fourth quarter write off. (Page 8)

4) Loan loss reserves as a percent of average assets are at the highest level ever - 1.35% - so the industry is at least prepared for what is coming. Will it be enough? Time will solve that mystery. (Page 11)

5) Other Capital Ratios still look sound at year end. (Page 14)

6) Page 17 is a scary one, detailing non current loans for the last five quarters. take at look at the chart for 1-4 family loans, which is 49% of assets for the industry. Also, construction and development non current loans are also rising sharply.

7) Page 18 is another scary one. Although there are only 11 problem thrifts at year end, look how bad it could get - there were 200 problem thrifts in 1991.

Fourth Quarter Thrift Report

It's Official, Securitization Sucks

It took them long enough to prove what we all knew in our heart, but four members of academia just published a paper on it. This excerpt is from the conclusion:

"The goal of this paper is to empirically investigate whether securitization had an adverse effect on the ex-ante screening activity of banks. We exploit a specific “rule of thumb” in the subprime lending market to generate an instrument for ease of securitization. Comparing characteristics of the loan market above and below the ad-hoc credit threshold, we show that securitization does indeed weaken the screening incentives of financial intermediaries."

"An 80% increase in securitization volume is on average associated with about a 20% increase in defaults. These defaults are being driven by characteristics of the loan or the borrower that are unobservable to both the researchers and the securities market. That we find any effect on default behavior in one portfolio compared to another with virtually identical risk profiles, demographic characteristics, and loan terms suggests that the ease of securitization may have a direct impact on incentives elsewhere in the subprime housing market, as well as in other securitized markets."

Full Paper

Insider Buying?

"Sharper Image Corporation announced that it had commenced a case under chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. The Company intends to continue to conduct business as usual while it devotes renewed efforts to resolve its operational and liquidity problems and develops a reorganization plan."

So much for insider buying:

Insider 1

Insider 2

and the Smart Money.

Sub Prime Primer

One of the funniest things I have read in a long time:



Sub Prime Primer

Community Bank Conference

I attended the Supercommunity Bank Conference earlier this week, and here are some of the things that I learned at the conference:

1) The conference was very "unattended" and somber. This was obviously due to the current investing climate and interest in financial stocks, but more specifically, was caused by a contraction in money flowing into funds that specifically invest only in community banks. Many of these funds have closed recently as the prospects for buyouts, and the premiums therein have disappeared.

2) There were only one or two banks from Georgia at the conference, strange since the conference was held in Atlanta. I later heard that so many Atlanta banks are in trouble that they stayed away from the conference. The average bank in Atlanta, according to the scuttlebutt at the conference, has a 6% of its assets in the non performing category.

3) I learned of the existence of something called an "interest reserve" on the books of banks. When a borrower makes a payment, not all of it hits the income statement. Some of it is put into a "reserve account" so when loans become non performing, it goes against this reserve, thereby delaying the recognition of non performing assets. This may be why there has been a lag between the deteriorating economy and an increase in past due and non performing assets by banks.

Festival of Stocks # 75 - February 11, 2008

I am happy to present the Festival of Stocks for this week. This is the third time I hosted it, and I hope to do it again some day.

Super Saver pans the MSFT-YHOO merger in his post at Microsoft and Yahoo! Merger - The Beginning Of The End on his blog My Wealth Builder.

Ryan talks about various leverage strategies at What Loans Can I Get to Invest? posted at Millionaire Money Habits.

FIRE Finance makes a convincing case for a buy and hold strategy posted here Investing - The Mistake Of Timing The Market The blog is FIRE Finance.

Silicon Valley Blogger looks at all the evidence and decides that an indexing strategy is the best one to use. His post is here at Why Most Investors Don't Make Money In The Stock Market. Take a look at his other posts at The Digerati Life.

George, the glorious leader of the Festival, loves free cash flow and presents Consistent Cash Creators posted at Fat Pitch Financials .

American Dividend Investor is a new blogger on the scene and in his second post presents 3M - MMM. His goal is to inform individual investors about both the benefits of a dividend growth investment strategy as well as provide them with a thorough analysis of individual dividend paying American securities.


Freddie L. Sirmans, Sr. tells it like it is with his post called COLD STEEL RAW BUCK NAKED ECONOMICS 101 in his blog entitled CAN US ECONOMY SURVIVE DOOMSDAY?. Although the post was a little dated, it is noteworthy for it prescient take on the dollar and other problems the United States is facing.

KCLau presents our first international post of the Festival called Withdraw EPF Money for Home Loan Installment: How it affects your Retirement Fund posted on his familiar blog here at KCLau's Money Tips.

Alex Garcia presents Where to find value investing ideas? posted at Contrarian Value Investing. Alex gives an excellent list of resources that he uses to pursue his passion of Value Investing.

Our second post dedicated to finding superior dividend stocks is posted at Dividends4Life: The Winning Score - Part 1 of 2 . Look for Part II when it is posted.

Deb discusses the implications of the MSFT-YHOO deal in his post entitled What Does The Yahoo/Microsoft Debate Mean For The Rest Of Us? on her blog at Marketvise. He gives a good run down of both sides of the issue. Marketwise is dedicated to helping the small investor level the playing field

Dorian Wales puts in a plug for buy and hold investing at The Personal Financier: Be the Turtle - Why Timing the Market is Impossible on his blog Personal Financier.

Jed Norwood discusses Foreign Currency Trading at Forex Trading Secrets Building a Profitable Trading Account posted at Jed Norwood. The trend is your friend in just about any market it seems.

Rob Moshe's post is not related to Stocks, but I admire his willingness to serve humanity rather than wallow in the pool of greed that infests Wall Street. His post is at Live Your Best Life By Serving Others on his blog at Rob Moshe.

When I first saw the headline of Ford, GM to Acquire Each Other posted at Avant News, the first thought that went through my head was "Hey, not a bad idea." It took me a minute to realize that it was a joke. I urge you to bookmark the site and peruse it when the market is having one of those 300 point down days, and you can do nothing but watch.

Debbie writes about Free College Money Part 2: Tax Programs posted at American Consumer News. This was a timely article for me since I have a child entering college in the fall.

Jorge H. talks about Fed Fund Futures at How to Read Fed Funds 30 Day Futures posted at My Adventures into The Street.

Rob Hanna gives his opinion on technical aspects of the market in his post Is Leadership Breadth Important For A Successful Bottom? posted at Quantifiable Edges.

Monevator makes the case for exposure to commodities despite the economic slowdown that we are struggling through in his post entitled How to harvest wheat and mine gold using ETCs. His blog is Monevator.com.

Dobromir presents our third article on dividend stocks: Is Realty Income (O) a good stock to own? posted at Create Increasing Passive Income from stocks with above average dividend growth.

Leon Gettler discusses the connection between trading and drug addiction in his post The brain: hard-wired for risky trades posted at Sox First.

Babak gives us a review of the market for January, a tumultuous month posted here at What Caused The January Waterfall Decline? His full blog is Trader's Narrative.

James Cullen talks about why he thinks it is too early to buy Sherwin- Williams posted at Brush Up on Sherwin-Williams (SHW): But Still Too Soon to Buy . Read about more stocks that he and his colleagues like at College Analysts .

Investing Angel gives some tips on avoiding con artists. Read the post here at How To Avoid A Stock Scam posted at Stock Tips.

Mike presents The Bottoming Process 020708 posted at Stock Market Trading.

Davy Bui presents our second international entry and discusses SK Telecom posted at Enlightened American.

Conference Time

I've decided to personally investigate the credit crunch so tomorrow I am heading to Atlanta to attend the Super-Community Bank Conference. This organization holds five regional conferences every year, and the Southeastern event is February 11 and 12. None of the banks are household names, with most having a market capitalization less than a billion. This will make it more interesting as I can get a good read on Main Street credit conditions.

Once Again - What Credit Crunch?

A poll conducted by the the National Federation of Independent Business in December 2007, came out with some surprising results:

"The net percent of owners reporting loans harder to get in recent months was unchanged at a net seven percent (eight percent said “harder,” one percent said “easier”, the average this year is six percent), typical of readings for the past several years. Only four percent of the owners cited the cost and availability of credit as their number one business problem."

"The net percent of owners expecting credit conditions to ease in the coming months was a seasonally adjusted net negative 10 percent (more owners expect that it will be “harder” to arrange financing), two points lower than November and below the average reading for the year. This indicates that some owners now see credit tightening on Main Street in spite of the Federal Reserve’s expansionary policies. But rates are falling and there was no change in the net percent of owners reporting credit harder to get."

The full report is here.

The material is a copyright of the NFIB Research Foundation. © NFIB Research Foundation.

Credit Crunch?

So is there really a "credit crunch" out there? What of these two facts:

Warren Buffett, the billionaire investor said "money is still available and reduced interest rates make it quite cheap."

Two additional questions were asked in a special poll of the ISM non-manufacturing panel in January. (From ISM report dated Feb 5, 2008)

Question - Is the turmoil in financial markets having any effect on your firm's ability to obtain regular or additional financing?

Yes — 14.6%
No — 85.4%

MBIA vs. Ackman

During its mammoth fourth quarter conference call that lasted 4 hours, MBIA took a shot at William Ackman:

"One other side benefit from our decision to accept questions only in writing. We clearly acknowledge we are taking the microphone as it were out of the hands of those inclined to ask questions of us. In the recent past, several such people have abused the privilege and used it as a soap box to raise criticisms, complaints, ramped or failed to ask coherent questions. Many of these people have effectively become adversaries of our Company, our employees, our clients and our business relationships. Many of them have demonstrated no problems finding media outlets to proselytize their messages against our Company. We see no reason to provide them with another forum to do so."

Auction Rate Securities Bite Again

Another company has taken a write down as a result of holdings in its investment portfolio. This time the company was Bristol-Myers Squibb (BMY). We wrote about the problems with these auction rate securities in a blog post from December:

The Problem with Auction Rate Securities

BMY took a $275 million write down due its poor investment decision.

Dugan Speech

John C. Dugan is the Comptroller of the Currency, and yesterday he gave a speech to the Florida Bankers Association. The Office of the Comptroller of the Currency (OCC) is but one of five regulators of banks in the United States. The five are:

The Office of the Comptroller of the Currency (charters, regulates, and supervises all national banks. It also supervises the federal branches and agencies of foreign banks)

Federal Reserve Board (state chartered banks that are members of the Federal Reserve System and bank holding companies)

Federal Deposit Insurance Corporation (insured state banks that are not members of the Federal Reserve System)

Office of Thrift Supervision (savings and loans)

National Credit Union Administration (credit unions)

Dugan mentioned some interesting information regarding banks and the risks they face.

1) The ratio of commercial real estate loans to capital has nearly doubled in the past six years, to 285 percent.

2) Over a third of the nation’s community banks have commercial real estate concentrations exceeding 300 percent of their capital, and almost 30 percent have construction and development loans exceeding 100 percent of capital.

3) Over 60 percent of Florida banks have CRE loans exceeding 300 percent of capital, and more than half have C&D loans exceeding 100 percent of capital.

4) Indeed, during the past year national community banks have experienced a significant increase in nonperforming C&D loans. As of Sept 30, these loans amounted to 1.96 percent of total C&D loans, a rate that was more than twice that of a year earlier.

5) In Florida, that trend is even more pronounced. While nonperforming loans a year ago were 40 basis points less than the national average, the figure has increased to 3.34 percent of total C&D loans. That’s 70 percent greater than the national average and an almost eight-fold increase in one year.

6) Thus far overall nonperforming CRE loans, even in the area of residential construction and development lending, are a long way from approaching historical peaks.

It should be a fun year for the Banking Industry.

Commercial Mortgage Delinquencies Head Up

Delinquency rates on Commercial Mortgages steadily increased during 2007, according to recent reports from several different groups. According to Foresight Analytics, rates were:

4Q-07 - 1.7%
3Q-07 - 1.4%
2Q-07 - 1.1%

These rates are still very low and not a worry yet, but they are sure to head higher in 2008.

The Federal Reserve also reported a 1.94% delinquency rate in the fourth quarter of 2007.


Commercial Mortgage Delinquencies